Tag Archives: europe

Cognitive Dissonance and Global Macroeconomics

One of our readers not only suggested this post, but even sent me all the links; I’m just now getting around to writing it up. Thanks.

There has been a lot of talk about global imbalances, with most opinions varying from somewhat important (us) to very important (many global policymakers). Here’s Jean-Claude Trichet, for example, president of the European Central Bank, as reported by Reuters:

“The G20 has to address the issues of the domestic large imbalances between savings and investments, and of the set of unsustainable external imbalances.

“We know that these imbalances have been at the roots of the present difficulties. If we don’t correct them, we’ll have the recipe for the next major crisis. And this of course would be totally unacceptable.”

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Payback Time

Once upon a time there was a president named George. He liked to do things his own way, which annoyed some of his “friends” in Europe. But then a new president named Barack was elected, who not only promised to be nicer to his friends, but was actually very popular in most parts of the world. And the people of the world thought we would see a new era of international cooperation, at least between the U.S. and Europe.

Not so much.

On this side of the Atlantic, the Obama administration and the Fed have been working night and day in an attempt to turn around the economy: Fed funds rate reduced to zero, $800 billion stimulus package, new plan to aid struggling homeowners, new plan for buying toxic assets, new budget, decision by the Fed to buy long-term Treasury bonds, new domestic regulatory framework outlined this week, etc. We’ve been plenty critical of various aspects of the U.S. response, but at least they’re trying.

(Continental) Europe, by contrast, has decided they’ve done enough and it’s time to sit back and watch.

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The Smell Of Coffee

The late Rudi Dornbsuch of MIT had a way of cutting to the chase, preferably in public and with a minister of finance present.  He knew a huge amount about financial crisis, and could distill a lifetime of study and involvement in collapses succinctly: “it always takes longer than you think; but when it happens, it always happens faster than you can imagine.”

The latest credit default swap data for European banks bring Rudi’s perspective to mind – for the United States.  We’ve debated this week what to do about U.S. banks, arguing about which unappealing options are less bad.  In my view, the choice is not “nationalize vs. don’t nationalize,” but rather “keep our current partial nationalization/bottomless pit subsidy system vs. start down the road to reprivatization.”

But, honestly, this entire debate may be overtaken by events.  Continue reading

Europe Is in Bigger Trouble than the U.S.

This is a theme that Simon in particularly has been sounding. Now, according to the Telegraph, a confidential European Commission memo confirms this. To review, the basic problems, relative to the U.S., are:

  • Disproportionately large banking sectors (the Iceland problem) in some countries, such as the U.K.
  • High exposure to U.S.-originated toxic assets (up to 50% of those assets, I have heard estimated).
  • Major exposure to emerging markets, primarily Eastern Europe and secondarily Latin America, which have been harder hit by this crisis than anyone else.
  • Higher pre-crisis national debt levels (for many but not all countries).
  • For countries that use the euro, no control over monetary policy.

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Angry Europeans

I had a heated discussion about our new baseline scenario yesterday with some angry European politicians.  Specifically, the most agitated were from the eurozone and they find our assessment of the risks and likely futures in that region to be unacceptable.  In their view, this is an American problem and that is where the impact will be felt. Continue reading

More Danger for the Eurozone?

Back in the exciting days of October, Peter, Simon, and I wrote an op-ed in The Guardian about the potential for cracks to appear in the Eurozone, even possibly leading to one or more countries withdrawing from the euro. With so many other things to worry about, this scenario didn’t get a lot of attention. Since then, pressures have been slowly building. For example, the spread between the 10-year bonds of Greece and Germany has grown from around 30 basis points during most of the decade to over 1.5% now. (The picture below is from last week.)

Greece-Germany

According to an FT chart (sorry, can’t find the link), Greece also has to raise 20.3% of its GDP in debt next year (the equivalent figure for the U.S. is 10.3%), so the spread should only get bigger.

The Eurozone is based on the idea that a single monetary policy can serve the interests of all of the member countries. The problem is that when macroeconomic conditions vary widely between countries, they will have different interests. In a severe crisis, some countries may be tempted to (a) engage in quantitative easing (of the sort the Fed is beginning to do) or (b) implement a large fiscal stimulus (of the sort that Pelosi, Reid, and Obama are about to do). (a) is impossible for a Eurozone member, and (b) is constrained by limits on deficit spending, although I believe those limits are honored more in the breach than in practice.

In any case, the potential problems are getting big enough that Martin Feldstein has weighed in as well. Hopefully this will draw more attention to the issue. It may still be a low probability, but the economic and political consequences of undoing the greatest step toward European integration in, oh, the last thousand years would be huge.

Oh, It’s Nice to Have the World’s Reserve Currency

When times are tough, governments have to borrow money. Luckily for us Americans, we can borrow it for free (for now at least – I know this isn’t going to be true forever): 3-month Treasuries have a yield of 0.01%, and even 3-years are at 1.25%, both below the rate of inflation. (By the way, even if you don’t have Bloomberg, you can get Treasury yields at Yahoo! Finance among other places.)

By contrast, the UK and Italy recently had unexpected trouble selling 3- and 4-year bonds, respectively, having to offer 10 basis points over similar existing debt. Mind you, this isn’t Iceland and Hungary we’re talking about here, but two members of the G7. Basically, investors are getting worried that deep recession (which crimps tax revenues) and large bailout packages, piled on top of existing debt, are creating the risk that at some point governments will either default on their debt or, in the case of the UK (which still controls its currency), inflate it away. The same concern can be seen in credit default swap spreads (remember Friday’s post?). Italy’s have climbed from single digits for most of 2007 and 40 bp in the summer to 141 bp.

Italy

More Interest Rate Cuts

Having woken up to the fact that inflation is not the thing to be worrying about, the UK, Eurozone (European Central Bank), and Switzerland all cut interest rates, the Bank of England by a completely unexpected 1.5 percentage points to 3.0%. Disappointingly, the ECB only cut rates from 3.75% to 3.25% (we earlier recommended an immediate cut to 2.0%), although Jean-Claude Trichet did leave open the possibility of further cuts in the future.

In the US, the low Fed funds rate (currently 1.0%) limits the potential benefit of further rate cuts. Europe still has a ways to go; so far, with the UK and the Eurozone set to contract in 2009, there’s no evidence that they couldn’t go further.

Update: What he said. (He, in this case, being James Surowiecki of The New Yorker.)

Smoke in the Eurozone

So far, rising spreads on credit default swaps have accurately predicted what sectors of the global economy would run into trouble next. The sharp rise in spreads on emerging market countries’ debt is old news. But recently, CDS spreads have been rising for countries that are part not only of the EU but of the Eurozone, such as Greece, Portugal, Ireland, and even Italy. The basic fear is that these countries may not be big enough to bail out their banks, so risk has spilled from the private sector into the private sector. The need for flexibility in monetary policy (currently ceded to the European Central Bank), the pain of a severe recession, and the increase in nationalist politics that often accompanies economic misery could lead one or more countries to abandon the euro. The costs of abandoning the euro would be very high, but it is a scenario that has changed from unthinkable to merely unlikely.

There are steps that policy makers can take now to reduce the threats of national defaults and of a fragmentation of the Eurozone. We discuss the situation and our policy proposals in a new op-ed in The Guardian.

European Response to the Financial Crisis

Just a couple weeks ago, European finance ministers were insisting that the credit crisis was an American invasion that they were adequately prepared to repel, with German Finance Minister Peer Steinbrueck insisting that an American-style rescue plan was not required in Europe because the financial crisis was an “American problem.” As we’ve learned over the past few weeks, things change very fast. Although European leaders now appreciate the seriousness of a crisis that threatens their economies every bit as much as the American one – perhaps more, judging by the number of bank bailouts over the last few days – they have not been able to implement solutions even on the scale of the Paulson plan. The on-line Economists’ Forum of the Financial Times published (Tuesday morning in the US) a new op-ed by Peter Boone and Simon Johnson describing the challenges facing European policymakers and presenting some concrete solutions – including interest rate cuts and bank recapitalization, for starters.

Update: Martin Wolf’s latest column for Wednesday’s paper, just out (Tuesday evening in the US), takes similar positions.  In the column, Martin discusses how the deepening crisis over the last week has led him to change his position.  Many in European leadership positions follow Martin’s views closely, so hopefully his forceful arguments will have an immediate effect.